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SEC Probes Shorting of Bear's Stock

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By David Cho
Washington Post Staff Writer
Friday, March 21, 2008

An unusual spike in trading of Bear Stearns shares preceded the collapse of the 85-year-old Wall Street institution last week, and the Securities and Exchange Commission is looking into this activity, said a person familiar with the matter.

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In particular, the SEC is examining a surge in short selling that occurred days before the trouble at Bear Stearns was revealed publicly.

In a short sale, a trader borrows shares and then sells them in the hope the price will fall and he can buy them back at the lower rate before returning them to the owner. The more the stock falls, the more the trader makes.

SEC spokesman John Nester declined to comment on whether the agency was looking into the trading of Bear Stearns stock.

Bear Stearns's collapse could have triggered massive losses at other investment banks and threatened the nation's financial system. But the firm avoided bankruptcy by agreeing Sunday to sell itself to J.P. Morgan Chase in a deal brokered by the Federal Reserve, which made an unprecedented pledge to take the risk of up to $30 billion in questionable assets on Bear Stearns's books.

J.P. Morgan will pay $2 a share for Bear Stearns's stock. The stock traded as high as $70 last week.

Bear Stearns executives are looking into whether rumors spread by former disgruntled employees or hedge funds triggered a run on the bank, said a company official who has been privy to those discussions. Last week, whispers of a cash crunch at Bear Stearns led many clients to pull their money out.

The short sales being examined by the SEC involve a specific option called a put, which allows a trader to set a price triggering the sale. Many of these sales involving Bear Stearns predicted a precipitous fall in its stock.

The number of short sales with this option jumped from 167,439 to 465,820 on March 10, six days before the buyout was announced, according to Schaeffer's Investment Research, which tracks this type of data. That increase was highly unusual. On March 13, 25,246 short sales with put options that bet the stock would fall to $20 were initiated, even though the stock had been trading above $50 most of that day.

On Friday, 25 percent of Bear Stearns's shares were being sold short, the highest level since Wall Street's credit problems began last year and five times the average for most stocks, said Tim Smith, president of Data Explorers. Shares fell, closing at $30. By the close of trading, Bear Stearns was the seventh-most heavily shorted stock in the Standard & Poor's 500-stock index.

That activity has prompted speculation that someone may have been trying to harm the firm.

The rise in short selling does not necessarily mean that market manipulation was taking place, but the spike in short trades occurred quickly, Smith said. Somehow, "people got inklings of what might be happening."

A growing number of investors who own the stock are actively opposing the buyout, which needs the approval of shareholders. Billionaire Joseph Lewis, who owns 8.4 percent of Bear Stearns, said in a security filing yesterday that he would launch a campaign for a new deal. Lewis has lost more than $1 billion on his investment.

The firm was also sued by the Police and Fire Retirement System of the City of Detroit, which owns 13,500 shares. The pension fund asked a Delaware judge to halt the deal.

"The sale price does not reflect the value of Bear Stearns," the complaint says. "Shareholders are being shabbily treated given that the transaction was not designed to maximize or even salvage their equity." A separate lawsuit was filed by shareholders in New York on Monday.

Meanwhile, Charles E. Grassley, (R-Iowa), the ranking member of the Senate Finance Committee, is asking questions about what happened to Bear Stearns. Yesterday, he asked his staff to closely examine how the deal was structured and to get more details on the Fed's offer to loan funds to J.P. Morgan.

In exchange for the money, J.P. Morgan was able to put down risky mortgage securities as collateral. If these securities fall in value, taxpayers would be on the hook to cover the loss.

"I want to understand what the downside risk for the taxpayer is and any upside potential," Grassley said in a statement. "Another long-time interest of mine is how insiders such as senior executives are treated in these kinds of deals. Corporate bigwigs shouldn't be able to profit from a deal while employees, shareholders, and creditors have to carry the burden of a company's demise."


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